The IRS has a lot of power. This power stems from the broad Congressional grant of authority to examine books and records to enforce our tax laws. Since taxes impact every individual and business for every transaction (and even inactions), this allows the IRS to audit and inquire into just about anything it wants to.
There are limits to this power. These limits are found in the summons rules as the IRS summons is the final tool the IRS has access to get records and information from “uncooperative” parties.
The IRS will often use this power to investigate civil tax matters as a ruse to gather information to use to bring a criminal tax case.
The recent Almeleh v. United States, No. MC-22-00012-PHX-MTL (D.A.Z. 2022) case provides an opportunity to consider these issues.
Facts & Procedural History
This case involves six IRS summons issued to the treasurer of a business. The business used a captive insurance arrangement. The IRS summons was about the business and its captive insurance company.
Prior to the IRS issuing summonses, it had issued Information Document Requests (“IDRs”) to the petitioner. The petitioner submitted responses to the IDRs.
The IRS issued the six summonses arguing that the petitioner did not fully respond to the IDRs.
The IRS’s Discretion & the Powell Factors
The IRS has broad discretion to examine books and records. This discretion is not unlimited, however.
The IRS’s audit powers do not allow the IRS to harass taxpayers or to fish for information that is not likely to relate to a violation of our tax laws.
One check on the IRS’s powers is the Powell factors. These factors were announced by the court in United States v. Powell, 379 U.S. 48 (1964). These factors limit the IRS’s ability to enforce its summons. Before getting into these factors, it’s helpful to pause to consider the IRS’s process for gathering information on audit.
About IRS IDRs & Summonses
The IRS will typically voluntarily solicit information and then, based on that information, issue IDRs to gather additional information. This information may be records or explanations.
The IDR is used by the IRS to document the documents or information requested and to document when the request was made.
The audit process typically involves responding to IDRs issued by the IRS.
If the IRS does not get a response or is not satisfied with the response, the IRS’s first remedy is to issue an IRS summons. The IRS summons itself is just a more formal request that is very similar to an IDR.
If the summons is not responded to or if the IRS does not think the response was adequate, it can ask the U.S. Department of Justice to try to enforce the summons. The U.S. DOJ attorneys often decline to enforce IRS summonses.
If the U.S. DOJ agrees with the IRS, it will file suit in U.S. District Court seeking an order enforcing the summons. This invokes the court’s ability to use its contempt powers to encourage the recipient to comply with the IRS summons.
The Powell Factors
This brings us back to the Powell factors. While the Powell factors are considered by the court in summons proceedings, you can see from the explanation above that the Powell factors really apply during the IRS audit. They set the standard for what records one has to provide to the IRS during the audit (or if it is an IRS collections case, during the IRS collection process).
The Powell factors say that a court is only to enforce an IRS summons if the IRS can establish “good faith” by showing that the summons:
- is issued for a legitimate purpose
- seeks information relevant to that purpose
- seeks information that is not already within the IRS’ possession and
- satisfies all administrative steps required by the United States Code.
The second and third points are those that are most often cited by taxpayers and others for not responding to or providing information to the IRS under audit. Also, one cannot be asked to produce records or information they do not possess. This is also a common defense.
The Legitimate Purpose Factor
The legitimate purpose factor can also be disputed. These disputes often involve situations where the IRS agent may be overreaching or engaging in conduct that is perceived to be harassment or bad faith.
This opinion sets out a summary of the law that has been developed for this factor:
The United States Supreme Court outlined the standard for evaluating bad faith in United States v. Clarke:
[T]he taxpayer is entitled to examine an IRS agent when he can point to specific facts or circumstances plausibly raising an inference of bad faith. Naked allegations of improper purpose are not enough: The taxpayer must offer some credible evidence supporting his charge. But circumstantial evidence can suffice to meet that burden; after all, direct evidence of another person’s bad faith, at this threshold stage, will rarely if ever be available. And although bare assertion or conjecture is not enough, neither is a fleshed-out case demanded: The taxpayer need only make a showing of facts that give rise to a plausible inference of improper motive. That standard will ensure inquiry where the facts and circumstances make inquiry appropriate, without turning every summons dispute into a fishing expedition for official wrongdoing.
573 U.S. 248, 254-55 (2014). “Bad faith exists where a summons is issued without a legitimate or proper purpose, to abuse a court’s process, to harass a taxpayer, to improperly use the requested information, or otherwise to go fishing.” Maxcrest Ltd. v. United States, 703 Fed. App’x. 536, 537 (9th Cir. 2017).
As you can see, these rules capture bad faith and require some evidence of a motive for bad faith.
In this case, the petitioner argued that the IRS’s six summonses were abusive as they relate to a barrage of IDRs issued with no time to respond, in an effort to convince the petitioner to concede a tax issue for the business:
For example, [Agent] Guo issued IDRs 1-4 all at once on 3/8/2021 and issued IDRs 5-12 all at once on [3/15/2021]. (Michele Decl. at ¶ 25). IDRs 1-4 were given 21 days to respond, or 5.25 days per IDR. (Michele Decl. at ¶ 25). IDRs 5-12 were given 15 days to respond, or just over 2 days per IDR. (Michele Decl. at ¶ 26). Michele felt overwhelmed and harassed upon each of the IDR dumps. (Michele Decl. at ¶ 22).
The evidence also included an admission by the IRS agent that his prior summonses were invalid.
The court did not have sufficient evidence in its record supporting the taxpayer’s position. Thus, it relied on the IRS’s records. The IRS’s records no doubt didn’t record its efforts to pressure the taxpayer. The court upheld the summonses on this basis.
The allegations and that the taxpayer had to resort to a motion to quash the summonses suggest that the IRS agent did engage in bad faith tactics to force a concession by the business. IRS agents do occasionally engage in this type of wrongful conduct. IRS agents also assert that IDR responses are “inadequate” when the taxpayer has provided all records and information in its possession. As this case shows, those who are working with the IRS should not cave to IRS IDR or summons tactics. They should require the IRS to get a court order and defend their position in court.